Gross Domestic Product and Real GDP

Gross Domestic Product What? What? Where? Where? When? When? How? GDP is a measure of the value of all final goods and services newly produced in a country during some period of time.

Product WeightValue Adding Unlike Products 7 tapes + 3 CDs _____________________________ ?????? $10 per tape $25 per CD ___________________________________________ $70 worth of tapes + $75 worth of CDs ______________________________________________________________________ $145 of tapes & CDs Table 6.1

Intermediate & Final Goods Intermediate goods Goods that undergo further processing or added-value before being sold to consumers Final goods New goods that undergo no further processing before being sold to consumers Double counting problem

NZ System of National Accounts Every day there are millions of transactions taking place in the New Zealand economy: businesses buy and sell goods and services Government collects taxes and makes transfer payments to beneficiaries people are paid for the work they do and use this income to buy food or pay rent.

NZ System of National Accounts Measuring these transactions is a huge and complex task but one which is essential to understanding how the economy operates. In New Zealand, as in most other countries, these transactions are classified, measured and recorded in the national accounts NZSNA

Three Ways to Measure GDP Expenditure approach Income approach Production approach

Expenditure Method Table 6.2 Consumption Investment Government Spending Net Exports National Expenditure = C + I + G + (X – M)

NZSNA Terminology Table 6.2 Consumption Investment Government Spending Net Exports Final private expenditure Gross fixed capital formation Government final expenditure Exports of goods and services – Imports of goods and services.

Unplanned Investment Unplanned investment refers to goods produced but not sold. In the NZSNA these are called “increases in stocks”. They may be positive or negative. The symbol is Δ R. They should be included in GDP as they are products produced in this time period.

GDP – Expenditure Method National Expenditure = C + I + G + (X – M) Increases in stocks Δ R GDP = C + I + G + (X – M) + ΔR + sd Statistical discrepancy used to balance

GDP – INCOME METHOD. The total of all incomes in the economy = National Income. Plus depreciation. This is an expense incurred in production however not paid out in income. Plus net indirect taxes. These are included in expenditure method (products are measured at market price) and so must be added with this method.

NZSNA Terminology Table 6.2 Wages and salaries Gross Profits Depreciation Net Indirect Taxes Compensation of Employees Operating Surplus Consumption of fixed capital Indirect taxes minus subsidies.

GDP – INCOME METHOD Compensation of Employees Operating Surplus Consumption of Fixed capital Net Indirect Taxes

Calculating GDP $ Million Operating Surplus21,000 Imports of Goods and Services15,000 Increase in Stocks2,000 Consumption of Fixed Capital4,000 Final Consumption Expenditure by Government10,000 Final consumption Expenditure by Private Sector41,000 Compensation of Employees35,000 Exports of Goods and Services16,000 Net Indirect Taxes6,000 Gross Fixed Capital Formation12,000 GDP Income Method

Calculating GDP $ Million Operating Surplus21,000 Imports of Goods and Services15,000 Increase in Stocks2,000 Consumption of Fixed Capital4,000 Final Consumption Expenditure by Government10,000 Final consumption Expenditure by Private Sector41,000 Compensation of Employees35,000 Exports of Goods and Services16,000 Net Indirect Taxes6,000 Gross Fixed Capital Formation12,000 GDP Expenditure Method

GDP – PRODUCTION METHOD The “value-added” for all firms in the economy are added to calculate GDP. Value-added can be measured by subtracting purchases from sales.

GDP – PRODUCTION METHOD $100 $150 $200 $300 Tree Grower Sawmill. Buys trees, makes furniture. Wholesaler. Buys furniture from sawmill, sells to shops. Consumers buy from shop. Value- Added Tree Grower $100 Sawmill $50 Wholesaler $50 Shop $100 Total $ 300

Consumer Price Index Is an index which measures changes in the price level for a country. The index is a “weighted” one which means products which we spend more of our income on have a higher weighting. The base year (the year the index series begins) is 1000

Consumer Price Index YearCPI% price level change % 30% 130% Measures rate of change in price level from the base year (2002). Rate of change between 2003 and 2004 is 1300 – 1222 * %

Change in CPI An increase in the CPI is called inflation. The price level increases. The purchasing power of money decreases. A decrease in the CPI is called deflation. Disinflation refers to a decrease in the inflation rate. The CPI is increasing at a decreasing rate.

REAL GDP Real GDP is nominal GDP adjusted for any changes in the price level. Real GDP is a better measure than nominal GDP as it is a better measure of quantity of production. Any inflationary or deflationary effects are eliminated.

REAL GDP In base year production is 4 $1 each. Nominal GDP at market prices is $4 In the second year nominal GDP is 4 $2 each = $8 CPI 1000 Even though nominal GDP has increased there is no increase in production. Real GDP in year two is $4/2000 * 1000 = $4 CPI 2000

The Business Cycle The rate of change in real GDP for economies often follows a cyclic pattern as is evident above. Times of economic growth are often followed by times of A slowing rate of increase or even a decrease.

The Business Cycle In times of rapid economic growth an economy will usually experience; Increasing employment Decreasing unemployment Increasing incomes Increasing government revenue Decreasing government transfers Increasing imports Increasing C+I Increase in inflationary pressures Lower output gap (difference between real output and potential output) or capacity constraints. %GDP change Time Economic boom

The Business Cycle In times of falling growth an economy will usually experience; Decreasing employment Increasing unemployment Decreasing incomes Decreasing government revenue Increasing government transfers Decreasing C+I Decrease in inflationary pressures Higher output gap %GDP change Time Economic Recession